Oct 232013 0 Responses

High Yield Investing

At ICMC we invest across the entire spectrum of investment opportunities. For practical purposes we group all investments into 10 different asset classes: US Equities, International Equities, US Fixed Income, International Fixed Income, Cash, Hedge Funds, Private Equity, Real Estate, Natural Resources and High Yield. Given the current fixed income environment, the High Yield asset class plays an ever increasingly important role in our clients’ portfolios.

Generating yield can be one of the most important considerations of an investment allocation as it not only provides income to a portfolio but also can contribute meaningfully to portfolio diversification. From 2009 through 2012 the “traditional” high yield investment markets (i.e. junk bonds) performed well as risk of the private sector was absorbed by the government through stimulus and quantitative easing programs. In that time income Investors were able to enjoy equity like total returns with a good margin of safetyin several high yield assets including Corporate Bonds, REITs, MLPs, Bank Loans, Mortgage Back Securities, and High Yielding Stocks (see table below).

Name

Symbol

2009

2010

2011

2012

YTD

American Capital Agency

AGNC

48.4%

29.4%

17.2%

20.73

-11.1%

Ishares 7-10 Yr Trsy Bond

IEF

-6.6%

9.4%

15.6%

3.66

-3.9%

Barclays Aggregate Bond

AGG

3.3%

6.4%

7.7%

3.76

-2.0%

Ishares S&P  US  Preferred Stock Index ETF

PFF

38.7%

13.8%

-2.0%

18.2

-0.9%

Spdr Barc High Yield Bond Yield

JNK

39.3%

14.2%

5.1%

13.46

1.9%

Vanguard REITs  ETF

VNQ

30.1%

28.4%

8.6%

17.63

3.2%

DWS Floating Rate

DFRPX

46.9%

10.3%

1.0%

8.77

3.5%

Pimco High Income Fund

PHK

88.7%

37.3%

-5.2%

40.06

8.1%

Calamos Convertible Fund

CCVIX

34.0%

10.8%

-3.9%

5.55

14.1%

Vanguard High Div Yield  ETF

VYM

17.2%

14.2%

10.5%

12.69

18.9%

Kayne Anderson MLP

KYN

83.0%

37.5%

13.1%

4.13

28.9%

YTD: January 2013- September 2013

However, 2013 has marked a difficult year for most traditional fixed income investments that tend to be, for obvious reasons, very sensitive to interest rates, and very adversely effected by rising rates (as rates rise, prices fall). As an example, 10yr Treasuries over the past year have moved up from 1.52% to 2.98% (almost a 100% increase) through September 2013. The largest move came from May through September 2013, which rattled the US fixed income market and other rate sensitive investments (dividend stocks among them). Since September, most yield focused investments have recovered slightly (see YTD in the chart above) as the appointment of Janet Yellen to Chairperson of the Federal Reserve most likely signals continued accommodative monetary policy and extended asset purchasing by the Fed.

The 10 year rate has pulled back to 2.61 % after having approached almost 3% in September, and remains historically low (see chart below)

Hi Yield Graphic

While Yellen’s appointment most likely ensures the Fed’s policies will remain accommodative and geared toward continued low rates, it is still unclear exactly what Dr. Yellen’s intentions are for policy moving forward. What can be assured is that over the long term rates will rise from their historical lows, and we will likely see increased volatility in the traditional fixed income space as speculators try to move ahead of Fed action and avoid sharp moves up for interest rates.

Despite uncertainty, income generation still represents an important component of overall return and acts as a good diversification tool against a market that is beginning to overprice growth stocks. It is likely after five strong years of equity market outperformance (2009-present) we will enter a period of market consolidation, during which the income component of a portfolio will represent an increasingly important role.

While we believe that most traditional income investments (corporate bonds) have quite a bit of downside risk due to the possibility of rising rates, there are many nontraditional yielding investments and strategies like MLPs, Floating Rate Securities, Convertible Bonds, Dividend Stocks, and other nontraditional funds that still show great upside potential and have tended to hold up better during times of rising rates (as experienced from May through September of this year). If investors are concerned about rising interest rate in the U.S., they should consider diversifying their portfolios and shift their high yield allocation to more nontraditional investments that still offer significant income and possible capital appreciation. If you would like to learn more about the strategies we are pursuing for our clients, please contact us today.

 

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